Did Goldman Sachs Just Win Big?

On p.A4 of today’s WSJ, Deborah Solomon and Jon Hilsenrath report more detail on the Treasury’s “Bad Bank” funding plan. On first (and third) read I’m not impressed, but we’ll go through all the available details and report back later.

For now, I just have one question. Isn’t this essentially the same plan that Goldman Sachs has been shopping around for the past month or so? There’s nothing necessarily wrong with that, of course. But it would be a huge win for Goldman and Lloyd Blankfein – explaining, for example, the confidence displayed in his recent FT article.

After eight years of Petronian Crony Capitalism, I’m shocked that such vulgar pandering to lobbying is still going on in plain sight. It suggests, not that things will stay the same, but actually get worse in the future.

As Burke said, in a quote much admired by Paine:

“Corrupt influence, which is itself the perennial spring of all prodigality, and of all disorder; which loads us, more than millions of debt; which takes away vigor from our arms, wisdom from our councils, and every shadow of authority and credit from the most venerable parts of our constitution.”

He was addressing, if I’m not mistaken, the King using money to influence the Parliament. Now we have other rulers. The mere fact that government is going to spend more money and raise a few taxes tells us nothing about how things might really change in the future.

Dear Simon,
Since you and most other economists agree that the right thing to do is to create an analog of the RTC or expand the FDIC to take over the bad banks, could you outline the logistics of how it can be done? The scale is orders of magnitude greater than anything attempted previously. It must be necessary to call up the National Guard, but where is the financial national guard? You would have to do it suddenly and confiscate the bad banks all at once, C and BAC and others. It is not hard to understand why the government is hesitant to do the right thing. The logistics must be daunting, requiring the resources of the Treasury, Fed, World Bank, as well as the good banks, among which I suppose GS is one. And it must be done suddenly, with preparation done quietly, to prevent a run on the bad banks. Very scary…..

I’ve read that the top 10% of U.S. taxpayers pay roughly 60% of total taxes. Doesn’t this mean the so-called “taxpayer bailout” is esentially a case of the top .001% of the population robbing the next 9.99%, assuming the looters of our financial system are among the relatively small number of super-wealthy?

I hope Bart Simms is right and that the administration is coping as best it can with a problem of unprecedented and almost unimaginable magnitude…what I described in an earlier post with tongue at least partially in cheek as Planetary Bankruptcy. However, even assuming this to be true, the “optics” are awful. The NYT described this problem well in its editorial this AM and Senator Whitehouse explained it clearly to Bernake in today’s senate committee hearing.

Warren Buffett said as much, noting that his secretary pays a higher marginal tax rate than he does (because his income isn’t income, it’s capital gains). Buffet pays a vastly lower tax rate than upper income middle class, such as doctors, programmers, business school professors, etc.

In other words, when capital is put to work, it’s taxed much less than when people are put to work (at least, the types of people who earn over 100k). The claim that the (upper) middle class is getting screwed has much validity.

The realpolitik argument is that taxing capital creates incentives for investors to shift money out of the country (aka, capital flight). Capital is relatively more mobile than labor, and so has more leverage in the international bargaining that drives tax rates.

The simpler version of this argument (that neocons make when they are trying get elected) is that taxing investment hurts the economy. This was nice so long as the outsourced jobs were blue-collar; it’s gotten harder to swallow as we’ve lost IT jobs, research jobs, finance jobs, etc.

What is fascinating about this situation – in the sort of sick and twisted B-grade horror movie way – is that the argument over what to do with the banks is a power-play between competing wealthy segments of society to determine who is dominant for the next 20 to 50 years.

It is not immediately relevant to most people, except in so far as it gets resolved sooner rather than later.

The justification for allowing bankers to trade fake assets for real assets – that flooding the financial system with unrestricted capital infusions is central to the recovery – is a thinly veiled disguise that everyone sees through.

The aspects of the Fed programs that are not focused on rescuing banks are limited in scope and generosity.

Net cost of $200 Billion, (AIG is rapidly approaching that all by itself, and that’s just what we’ve spent to date.)

What do we get out of the TALF?

The Fed agrees to loan money to “companies and investors that pledge eligible collateral to back the loan”.

In other words, the Fed is promising money to people who don’t need the money. In a normal downturn this would help (allows investment and expansion). Now, few are the folks who want to expand, and fewer still are those who have collateral.

I’m suspicious of who benefits from TALF – my guess is owners of AAA-backed securities who can trade the securities (at what valuation?) in exchange for 3 year loans at very low interest rates to stave off the wave of commercial property bankruptcies rapidly approaching.

I’m not necessarily against that… BUT

What about REAL SMALL BUSINESS? We’re helping property finance companies who have depressed assets and non-performing loans (or loans that are about to become non-performing) and are facing a capital crunch.

Small business? Toast. TALF is the equivalent of a political head fake.

As incompetent as Republicans have been for 8 years, they have a solid point – income rates on high income earners are subsidizing low income groups, AND ALSO the investing class.

The upper middle class is getting the shakedown in a big way. First by the market, next by govt. Their mortgage debt is crippling, their assets are gone, and their income is being eroded by new taxes.

This is particularly true if you live in a high cost of living area (Boston, NYC, California). CA got 77 cents back on every dollar it paid in federal taxes (that difference easily covers California’s state budget deficit and much much more).

Comment: The point – which got lost – is that Obama has a political challenge.

His policies currently rescue the very wealthy (by recapitalizing them so they can “invest”) and the very poor.

To enlist the support of the (upper) middle class – arguably, the demographic that rallied to his side in the election – he will need to offer them something more than vague promises. In spite of a thoroughly incompetent Republican challenge (led by Rush Limbaugh), Obama’s support is starting to fall.

(aren’t the billionaires the PE/hedgefund managers who are being backed as the folks to “clean up” the banks?)

what might you expect from what seems to be a de facto volunteer brigade/support group pitching in and doing their civic duty in order to allow the time and due diligence required to vet prospective staff need to fill those shameful Treasury staff vacancies.

…not to infer it’s all bad – it would be interesting to know how much money is being saved by leaving those Treasury positions vacant (or if those savings have already been wiped out by various hidden consultancy fees) but in one sense I’m more comfortable with the government sachs public private partnership model than the privatized nationalization model – or at least that’s what is sounds like

Could we get a workable variant of Romer’s Good Banks proposal moving forward?

Here are some of the apparent limitations which would need to be overcome by a Good Banks proposal:
– it takes time (especially for government) to create new banks and to attract people with the experience and connections to make sound lending decisions
– it’s important to avoid enabling Government to “choose winners and losers” through the credit system
– creation of good banks would cause a run on the old bad banks

Here is just one variation of his proposal that seems likely to get past some of these limitations.

We pass a statute to encourage Non-Bank Corporations incorporated in the United States (e.g. Sponsors) to do the following:
– Create or Acquire a Bank with a clean balance sheet, structured as a subsidiary banking company.
– Make a lump-sum initial or incremental investment in the Bank in the form of Common Stock, and submit a simple application (to the Secretary of Commerce-the Secretary) for a matching investment.
– The Secretary by statute would have 30 days to deny the application or to place a matching initial or incremental investment in the Bank in the form of senior convertible bonds, paying interest at the same rates as 90-day Treasury notes. (The details for later conversion to common are important details, but that I haven’t worked out yet). Each matching investment by the Government would be limited to a maximum (maybe $250 million) in order to create diversification and broaden the impact geographically and across different business. The Secretary’s ability to deny any application would be strictly limited to a few key financial strength criteria.
– If the Bank was not federally chartered, it would be required to apply for a federal charter within six months of receiving capital from the Secretary.
– In order to prevent depositors from running to these new banks, the enabling statute would put severe limitations on their ability to accept deposits for the first five years.
– The Sponsor would be specifically authorized by the statute to direct its new bank subsidiary to finance the purchase of the Sponsor’s goods and services for qualified buyers, subject to applicable FDIC regulations.
– One of the limitations to be specified by the enabling statutes would be specific limitations on the amount of such purchases which could be financed by the Bank. (I would think that the minimum allowable amount would be 100% of the amount of new or incremental capital provided by the Sponsor, but it seems appropriate that it ought to be as high as 300%, if the Sponsor is a well capitalized and respected participant in American business.)
– The available capital from the Federal government would be initially limited to $75 Billion. This would have the additional benefit of motivating Sponsor companies to act quickly to
– All Banks which receive capital infusions from the Commerce Dept would be authorized to borrow directly from the Federal Reserve at the lowest available rates available to any federal bank which makes loans to Non-Bank Corporations in the United States.
– Involvement in the affairs of the Bank by the Federal government would be strictly limited to the normal role of banking regulators to maintain the financial integrity of the Bank.
– (This might be necessary) After-tax retained earnings of the Bank could not be transferred out of the control of the Bank to the Sponsor until after the Federal government has divested itself of any ownership interest in the Bank.

4. Here are some of the benefits which seem obvious to me:
– Thousands of well-financed and well-connected Non-Bank Corporations have a compelling incentive to act to create thousands of strong banks with clean balance sheets. Companies who might participate include giants like IBM, Apple, Cisco Systems, and others.
– The federal government has the potential to double the reserve capital of these banks at attractive terms that create a powerful upside for Taxpayers.
– Given a relatively modest bank gearing ratio, this proposal could quickly create $1.5 Trillion in new business lending capacity, at a budgetary cost of only $75 billion.
– Each Bank’s own Sponsor has a shared commitment and risk sharing relationship with the Federal government.
– One of the central dictums of sound bank lending is Know Your Customer. Each Sponsor will have the ability and the incentive to connect its Bank to client firms whose business operations are reasonably well understood by the Sponsor. Each Sponsor company would have the potential to offer financing by its Bank to its creditworthy customers (on very competitive terms).

Years ago when the RTC was in business, I purchased my own mortgage and a car note from the RTC for pennies on the dollar. I sold the collateral for a significant gain. I get the sense the Private-Public Equity plays are creating something similar where the Players are on both sides. For instance, BOA can sell their debt to the Private/Public Equity [one of their own backed players] and buy it back for a slight gain to the P/PE players and then make the spread on the money by enforcing the default provisions in the paper. They get bailout money both ways and make insane profits off their own mistakes.

Excuse my potential ignorance — I am a relative beginner in economic matters — but the lower tax on capital gains is a second tax, right? Warren Buffett paid income tax (years back, but the point stands) on the money he uses to generate investment income, which is then taxed. If he had never paid income tax, he’d have a lot more money to invest. Let’s assume he was a high earner when he first earned the money he began to invest. Untaxed, he would have had 40% more to invest, and be 40% richer, all things being equal. If that were the set up, of course he should be taxed as if it were income. But capital gains tax is a second tax.

So, I read Lloyd’s article when it came out–it sounded as though it was written by a pack of New York attorneys. I was not shocked by any of the content.

However, I was a little bit miffed at Krugman’s complaining session on his blog yesterday (http://krugman.blogs.nytimes.com/2009/03/03/zombie-financial-ideas/)…ok…are we really creating a moral hazard? Maybe a little bit but its for the longer term good–and we are aware of what we are doing. Besides, will it matter if all the banks fail in 3-5 years? The moral hazard debate remains so academic and dare I say–irrelevant in times like these…that I’d really like to see more content on getting things done. We need experimentation…and boldness.

It’s not a second tax. You invest $100, you sell your shares of whatever for $150, the gain in capital (hence ‘capital gains’) is $50, which is taxed. You didn’t have the $50 before so it has never been taxed.